Yen Rising

Global banks want Japan's cash

By Jun Tamaki and Shotaro Tani

It was late September when Toronto-Dominion Bank (TD), one of Canada’s largest financial institutions, held a lavish party at a hotel overlooking Tokyo’s Imperial Palace. The event, which drew some 200 of the city’s financial insiders, celebrated the reopening of TD’s securities business in Japan.

TD’s decision to return after an eight-year absence is partly attributable to a seismic shift in the financial market. The Bank of Japan (BOJ) took interest rates into the basement, creating a glut of cash and a hunger for alternative investment options.

“Interest rates in Japan are low, so people are looking again to buy securities, investments that are higher yield, or are of different currency,” said Bob Dorrance, CEO of TD Securities, explaining the reasons for coming back. “Japan has one of the largest pools of savings in the [developed] world, and those savings are looking to earn a return and to be invested. Having a local presence with an experienced team will allow us to build and grow long-term relationships to provide a superior level of service to our clients.”

Changing the mindset of Japanese investors remains a challenge—there is still a strong preference for domestic bets. But, TD is hardly the only Western financial institution that smells business opportunities in Japan. The UK’s Standard Chartered Bank opened its own securities business last year, while Legal & General Group PLC, a British financial services company, will set up a Japan office this year. The common blueprint: to attract Japanese money that can be put toward projects and investments elsewhere with higher returns.

The Chinese are in on the action, too. Back in 2008, they gathered only about ¥100 billion ($887 million at current rates) in Japanese deposits. As of the end of March 2017, they had 12 times that amount, at ¥1.2 trillion. One of China’s four big state-owned commercial banks, Agricultural Bank of China (ABC), now has a branch in Japan. Interest rate differentials between the countries mean banks can reap quick rewards simply by taking yen deposits back to China, mostly through Hong Kong.

This is a sea change compared with a few years ago. Japan’s two lost decades of low economic growth—coupled with the 2008 global financial crisis—prompted foreign financial institutions to leave the country in droves. The number of international players in Japan was 131 at the end of fiscal 2012, down 17 from two years earlier. The tally was back up in fiscal 2015 at 164.

As for foreign bank branches, data from the Financial Services Agency put the number at 55 as of the end of June, up by two from a year earlier. This marked the first increase in 10 years.

BOND BLUES
For Japan’s own banks and insurers, life used to be much simpler: All they had to do was invest in Japanese government bonds (JGBs). The investments did not bring in big returns, but they did the job. Japan’s domestic banks held a record ¥117.8 trillion worth of JGBs as of March 2012.

That winning formula crumbled after Haruhiko Kuroda took charge at the BOJ in March 2013 and quickly launched monetary easing “of another dimension.” The final nail was the central bank’s negative interest rate policy, introduced in January 2016. Interest rates on JGBs plunged, making government bonds one of the least-attractive assets. The latest figures show banks now hold only ¥67.1 trillion worth of JGBs, roughly half the amount held in March 2012.

In this context, the decision last year by The Bank of Tokyo-Mitsubishi UFJ, Ltd. to cede its position as one of the primary JGB dealers is not surprising.

Mitsubishi UFJ Financial Group, Inc., the bank’s parent, pinned the decision on a “reorganization of the operations at banks and securities companies.” It was obvious, however, that the true reason was the difficulty of explaining to shareholders the rationale for investing in a loss-making asset.

For regional banks, the situation is even more complicated. At the end of May, they were holding a total of ¥86 trillion in dormant deposits, unable to loan or invest the money. The amount equates to just over 16 percent of Japan’s real gross domestic product.

With Japan’s financial institutions in a bind, foreign players are swooping in. Of course, the international heavyweights chasing Japanese money have their own pressing reasons for doing so.

FROM TORRENT TO TRICKLE
“He seems to be here again.” This was the gossip in Tokyo’s financial market recently—the “he” referring to Stephen Schwarzman, co-founder and chief executive of The Blackstone Group L.P., a US private equity firm. A source said Schwarzman, a close associate of US President Donald Trump, visited Japan twice in as many months for meetings with government officials and financial executives. His aim, apparently, was to market Blackstone’s $40 billion open-ended infrastructure investment fund.

Schwarzman has strong ties to Japan. Nikko Securities, now SMBC Nikko Securities, Inc., helped him through troubled times when he founded the private equity firm in 1985. But his recent visits might also be an indication that he is struggling to drum up cash for the infrastructure fund.

Blackstone secured $20 billion from the Public Investment Fund of Saudi Arabia, but the source said it had been counting on a much larger figure from the Saudis. Facing a budget deficit in 2017 for the fourth consecutive year, Riyadh is not splurging like it used to.

Another apparent miscalculation on Blackstone’s part relates to China. The source said, “China has become reluctant to move funds outside of the country, and the need to search for other investors became urgent.”

For years, Chinese money was all the rage in global finance, exemplified by a string of high-profile business acquisitions and real-estate investments.

That began to change last year. In November, banks received guidance to tell the central government about any foreign exchange transaction worth at least $5 million. The rule created an extra hurdle for funding overseas investments.

China also banned banks from selling more foreign currency than they buy. If a bank is doing this, it means it is supplying foreign funds to businesses. This, in turn, could contribute to capital outflows and the depreciation of the yuan.

The guidance and ban had immediate effects. Foreign direct investment by Chinese enterprises in the first six months of 2017 totaled $48.1 billion, down 45 percent from the same period last year.

China watchers are not anticipating a dramatic recovery in the country’s foreign investment any time soon. A notice the State Council issued in August appears to support their view—it restricts investments in real estate, hotels, entertainment facilities, and other targets while encouraging investments in countries that support China’s Belt and Road Initiative.

In short, only invest in what Beijing approves of.

YOUR MOVE, JAPAN
Since global financial institutions can no longer count on sponging up Chinese and Saudi money, they have turned to Japan by a process of elimination. Japanese money has not garnered this much international attention since the bubble days of the 1980s.

One might expect to see more urgency on the Japanese side.

In February, reports emerged that the Government Pension Investment Fund (GPIF)—one of the world’s largest public pension funds—would invest in a US infrastructure fund on orders from the Japanese government. Yet GPIF President Norihiro Takahashi quickly refuted the reports.

The leader of a major financial institution visited by Blackstone’s Schwarzman was also hesitant to open the vault. “We won’t shut the door in his face, because he took the trouble of coming to see us,” the executive said. “But seeing him does not automatically mean we will invest [in the fund].”

Still, the reality is that Japan is awash with money. Household financial assets exceed ¥1.8 quadrillion. Cash and deposits sitting in Japanese companies, excluding financial institutions, stood at a record high of ¥191.6 trillion at the end of June.

Playing ball with foreign institutions could be beneficial for Japan. Before tightening its capital controls, China dramatically increased its global influence with headline-grabbing foreign investments. Japan could do the same.

Some institutional investors are beginning to grasp the opportunity, namely trust banks and life insurers. Not long ago, they were bogged down with nonperforming loans and negative spread problems, respectively. Now players in both sectors are going on the offensive.

Mikio Ikegaya, CEO of Mitsubishi UFJ Trust and Banking Corporation, has earmarked ¥1 trillion for acquiring asset management companies. Nippon Life Insurance Company, Japan’s largest life insurer, is planning to invest ¥1.5 trillion over the next four years—mainly for acquisitions—and is in final negotiations to invest in US asset management company TCW Group, Inc. The question is whether other institutional investors will follow their lead.

Japan has a choice: resign itself to lost decades and financial obscurity, or recapture its mojo as an important player in global finance.